13 December 2017
Global monetary conditions tightening
The world economy continues to enjoy its best health since the Global Financial Crisis, with both emerging markets and advanced economies reporting stronger growth
The world economy continues to enjoy its best health since the Global Financial Crisis (GFC), with both emerging markets and advanced economies reporting stronger growth. The latest global growth forecasts indicate that world real GDP growth accelerated to 3.2% y-o-y in H1 2017; the strongest start to a year since 2010.
The coordinated global economic recovery is now stimulating inflationary prospects, forcing a number of central banks to move slowly towards a tightening bias for interest rates. The US Federal Reserve is leading the way in tightening monetary policy with plans to reduce bond buying by $50bn spread over US government bonds and mortgage backed securities. This will be reinforced by the likely new Fed Chairman Jerome Powell, who is the Federal Reserve chairman nominee.
Additionally, the European Central Bank (ECB), the Bank of England, and the Bank of Canada have all raised interest rates or announced reductions in QE since the start of the year.
Nevertheless, global monetary conditions remain extraordinarily loose, with major central bank balance sheets totalling $20tr (Chart 1). Even if the Fed runs down its balance sheet by $50bn a month as expected, this will be more than offset by continued QE by other central banks (Chart 2). With the Bank of Japan and the ECB still expanding their balance sheets, it seems more likely that global monetary conditions will remain highly accommodative in the year ahead.
Chart 1: Global central bank balance sheets by country
Source: Bloomberg, Grosvenor Research
Chart 2: Aggregate global central bank balance sheet, historic and projected
The UK has emerged as one of the weakest European countries in 2017, underperforming nearly every Eurozone market. Manufacturing activity picked up slightly in Q3, helped by the competitive exchange rate. Furthermore, the labour market also continues to improve, with the unemployment rate dropping to 4.3% - its lowest level since 1975 - in the three months to August. However anaemic productivity growth has held back meaningful wage rises. Over the medium term, the UK is forecast to have amongst the weakest growth of all G7 countries over the next 2 years.
Elsewhere in Europe, the region's positive economic news has been partially clouded by renewed political uncertainty. Catalonia's contested declaration of independence and subsequent annexation by Madrid casts a shadow over the impressive Spanish recovery. Catalonia represents a sizeable 19% of Spain's GDP and the wealthy region is an important source of government revenue. Evidence of the negative impact of Catalonia's upheaval is already showing up in retail sales, which contracted 1.6% y-o-y in October.
In Asia, China looks to be stabilising, although trend growth is expected to slow further in the coming years as the economy continues to transition away from an unsustainable investment-led growth path. The main risk in China remains the rapid accumulation of corporate debt, which has prompted the IMF and the OECD to urge Chinese authorities to urgently reign in its rising debt problem. On the political front Xi Jinping reinforced his power over the Chinese Communist Party at its most recent conference, ensuring that he will lead the country for the foreseeable future. In Japan, with the economy continuing to improve and the unemployment rate below 2%, the Abe government won a renewed mandate in national elections in March. This gives his ruling coalition a majority to push its policy agenda over the line, including controversial measures to rejuvenate the country's military capabilities.
Real estate market
In Q3, global transaction activity in real estate remained buoyant, despite elevated asset pricing. Europe and Asia Pacific - markets which are still at an earlier stage in the property cycle - both saw commercial real estate transactions increase by 4% to 58bn and $102bn respectively. However, in the US, investment volumes fell 9% in Q3 to $114bn, reflecting that it is at a later stage of the cycle.
A common theme across global markets is the disconnect between pricing and volume. While volumes look to be peaking, yields have continued to trend lower. Chart 3 shows that among the 17 prime office yields in the global cities that Grosvenor tracks almost three quarters are in low yield, low spread ‘overvalued’ territory.
Chart 3: Prime Office yield vs. spread over bonds, Q2 2017
Source: CBRE, JLL, IHS, Grosvenor Research
Note: Real bonds calculated as nominal less inflation target